Is P2P lending ethical or sustainable for the investor and borrower? There are some ethical issued in P2P lending investments. However, many platforms enable investors to control which loans they wish to invest in. Hence they also have a say in how ethical and/or sustainable their investments are.
P2P lending is not unethical. However, aspects of P2P lending is unethical and hard to control. Nonetheless, investors can choose their P2P lending investments and make sure they are ethical and sustainable for both the borrower and the investor.
Throughout this post, the ethics and morality of P2P lending will be discussed for better and worse.
Ethics of P2P Lending
The lending industry has the reputation of taking from the poor to make the rich, richer. The banks, credit unions and short-term lenders all have been followed by a witch-hunt of enslaving their borrowers with high-interest rates. However, it is essential to remember that lending is a business. You are not entitled to a car or a house if you can’t buy it outright. With that being said, short-term lenders are notoriously known for lending a rates of +50% annual interest, hence seen as unethical lending.
However, the introduction of P2P lending might be a way to put you on the side of the lenders to collect some profits from lending. Furthermore, you might even be able to do it ethically.
When thinking of ethical and sustainable investing, the typical investor thinks of the use of child labour, the conditions of the employees, social responsibility. While this can be a factor when being a P2P lending investor, the ethics of P2P lending are more focused on ethical loans. Hence the interest rates should be affordable, and the funding should not go towards funding of unethical projects.
Most P2P lending platforms also make it difficult to evaluate the ethicality of the loans. This is mostly due to the lack of transparency by most platforms which makes it impossible to make the proper due diligence of the investments.
Platforms such as Mintos has a column in the loan list, which indicates the borrowers’ APR (Annual Percentage Rate) on the specific loan. That means investors can choose to invest in loans with lower APRs.
Platforms such as Swaper whom issues Danish and Polish loans is a lot more ethical than loans granted to residents of Ukraine. The ethicality is better due to local laws that prevent colossal interest rates. In Denmark, the maximum allowed APR is 35%, and Poland wants to implement a maximum of 45% APR as well.
Therefore, it can be concluded that most short-term loans are unethical in the sense of reasonable interest rates. However, an argument could also be that P2P lending is the most ethical lending. This is mainly because people in desperate need of money now can go to loan sharks, lending companies, or accept personal bankruptcy and end on the street. Hence, lending gives the borrower time to find better solutions.
Now, that was the discussion of short-term loans for consumer. However, there is also loans for businesses. Many small businesses lack the funding to their projects. As the companies are small, they have limited results to show banks and hence can’t get approved for loans. Mostly because banks are conservative with money, and the businesses need years of proof for financial profits to acquire funding. P2P lending to businesses is a way to lower the barrier for companies who want to continue their business.
In times of financial distress such as the financial crisis of 2008 or the coronavirus in 2020, businesses have trouble getting financing through banks. These small businesses are sent on the verge of bankruptcy in financial crises’.
Therefore, lending to small businesses to help is not a bad thing.
Peer-to-peer Lending Ethics
In the discussion of Peer-to-peer lending (P2P lending), the acronym P2P lending is used for personal-, short-term-, quick-, and consumer lending. P2P loans are often placed with substantial interest rates. One reason is that the lending company has to cover their losses. The only way they can cover their losses is to have an interest rate high enough, so that the repaying borrowers pay for the defaulting borrowers. Another is to score more significant profits as a corporate company.
Payday loans have some quite shocking statistics found by the Consumer Financial Protection Bureau (CFPB). According to CFPB, 45 per cent of new lenders end up renewing their loan multiple times before paying the debt in full. Furthermore, 1 in 7 renew their loan more than 10 times. Lastly, 4 out of 5 loans are a part of the misery cycle where the borrower is unable to exit the debt. These statistics mainly occurred due to no/little regulation of the effective APR and unethical business.
The lending companies “trap” their borrowers inside loans with high-interest rates and fees. Given the short-term of the loans, the lending companies know that the borrower is short on cash, hence they offer to borrow them the money. When it comes time to repay, the borrowers have the same bills to pay and therefore can’t pay the loan. Hefty fees are added to the loan, in the form of a renewal of the loan.
Investing in P2P lending can, therefore be hard to justify based on the obnoxious interest rates. The borrowers get caught with a lot of unplayable debt. They have to obtain new loans to pay their old loans and then the misery cycle starts.
How to calculate the APR on a loan:
APR = (((Fees+Interest)/Principal/n)*365)*100
Where n is the number of days in the loan term, fees is any costs associated with the loan, the principal is the amount borrowed and interest is the interest paid on the life of the loan.
Examples of APR on different loans:
|Loan scenario||Principal (€)||Interest rate (%)||Interest (€)||Fees (€)||n (Days)||APR (%)|
|Standard Loan – Paid on time||100||20%||1,6||5||30||81%|
|Not paid on time – Penalty fee||100||20%||1,6||30||30||385%|
|Not paid on time – Penalty interest||100||80%||6,6||5||30||142%|
|Paid on time – Bigger fee, lower interest||100||10%||0,8||15||30||193%|
|Paid on time – Lower fee, higher interest||100||40%||3,3||5||30||101%|
From the examples of the APR, it can be concluded that you will most of the time prefer lower fees in exchange for a high-interest rate. However, the examples are arbitrary and do not reflect any real loans. This is simply a set-up scenario.
However, what can also be concluded is that APR is an inferior measurement on short-term loans. The APR method gets critique for showing high-interest rates while the actual costs it not that big. The difference is that unlike a mortgage where the borrowers has be to qualified and evaluated through their financial statements, any individual can obtain a short-term loan in less than 24 hours without any background checks. The lending businesses, therefore, secure their money with fees and high-interest rates for the short periods.
However, there are platforms who provide information about the borrowers’ interest rates. This makes it possible to invest in a loan with more peace of mind.
Peer-to-business Lending Ethics
Peer-to-business (P2B) lending is also known as P2P lending. The concept is the same. However, the borrower is different and therefore the concept functions just as with P2P lending, but with small differences. One difference is that businesses will get investigated or rather the P2P lending platform will conduct a due diligence for the project, which is up for funding by the borrowing business.
Business lending is an interesting topic when thinking of ethics. How do you secure that the funding towards sustainable companies which practice ethical behaviour? The truth is that it is very difficult to know what the funding is going towards. While most loans directly state the purpose of the loan P2P lending is a cost-efficient type of lending, and thus there is not as much control with the borrowers in contrast to traditional lending.
Looking into platforms such as Crowdestor, Debitum Network, Flender, etc. there are many different business loans. The problem with business loans is that P2P lending lacks general transparency. While a project might seek funding for expansion of their restaurant, there is no evidence that the funds are used to acquire a new building.
The business lending platforms typically makes the due diligence process and then tells their investors the expected return on investment and the information related to the borrower. The information provided is very different. A platform like Flender has very limited public information about the projects provided. Whereas a platform such as Crowdestor discloses a bit more, but still lacks a lot of transparency.
The ethical matters of the platforms also varies a bit. Crowdestor has previously posted investments in the fur industry. However, it came However, they also provides investments in forestry, which is an environmental and sustainable good idea.
While the return of the project was calculated to be around 26% annually over 2 years, investors gave strong opinions about such investments. This both does to show that people are not only for sale for a good investment opportunity, they also care about the social responsibilities.
Property-backed lending is what is seen as secure for most of the P2P lending investors. This is mainly because of 1 aspect only – the collateral. Short-term loans typically come with a buyback guarantee, whereas property-back loans is secured with collateral.
The collateral can appreciate or depreciate over time. However, the buyback guarantee with purchase the loan back in full if a borrower fails to repay their loan. With that being said, buyback guarantees only work if the financials are healthy from the loan originator. Otherwise, it is just a word on the loan agreement. However, the collateral can always to sold either to recover the full amount of the principal or fractions of the principal.
Property-backed platforms tend to disclose a bit more of their borrowers. Hence, the investor gets to do some minor due diligence of the projects. The information given is typically address, collateral type (and rank), and even financials. Two examples of providing good information is Estateguru and Crowdestate.
The best example of a property-backed platform is Estateguru. Estateguru provides detailed information about the borrower, the project, the communication between the platform and the project manager, financials, property appraisals, etc.
The address can be used to learn about the area, which is very important when investing into real estate. If a borrower were to build a residential complex in the middle of nowhere, it would be a very poor decision to participate in that investment as no people would live in nowhere (essentially). Furthermore, should you have jumped on the investment anyway and the project turns out to be a flop, collateral could save some of the losses.
However, when talking ethics it is much easier to invest in property-back deals. They are more prone to provide useful information which can enable the investors to look into both the companies and the area. This will allow the investor to find details of their social responsibilities. E.g. if the developers are rebuilding ghettos or helping local businesses.
How To Invest Ethically In P2P Lending
Investing ethically can be tough when looking to invest in P2P lending. Whether going for short-term loans, busienss loans, or property-back loans there are many things that are not transparent and thus diifcult to evaulate.
Taking the Sustainable Development Goals into consideration, goal 8 and 9 is the once that P2P lending investors can help to have an influence on. The goals states: Goal 8: Decent work and economic growth and Goal 9: Industry, Innovation, and Infrastructure. The goals emphasizes sustainable growth, infrastructure, and industrialization.
Investing in P2P lending in areas with poverty or general bad standing can help building the area for long term sustainable economic growth. Most P2P lending platforms issues loans from a board spectrum of Europe. The countries that are often available for P2P lending investments are Latvia, Poland, Portugal, Lithuania, Estonia, just to name a few. There are also platforms offering P2P lending investments in Zambia, Indonesia, and other more unfortunate places.
Using the statistics from OECD, it is possible to get some knowledge of which countries are more fortunate than others. From the statistics, it is clear that Zambia is in worse economic shape than Luxembourg. Funding in Zambia will, therefore be riskier. However, they will be going towards funding projects, people or infrastructure to help the country and their businesses grow.
So should you just throw your life savings into loans from third world countries? No, of course not. How much you should invest is another discussion which I have written about in another post. A good rule of thumb is to invest 5%-15% in speculative investments. It is risky, and you should be prepared for losses.
Moral compass: The most essential for investing ethically is to know your own moral compass. Is meat production unethical for you? Then you should probably investigate the loans for warehouse, production, and land development to make sure the loans are not used to fund storage of meat, production of cows, or land for animal keeping.
The moral compass can only be adjusted by yourself, and therefore it is essential to think of what is ethically okay for you as an investor. Furthermore, following social norms is not a bad indicator for if an investment is going to be a success or not.
Use information to research: The information which is provided by the P2P lending platforms can be used for research on the borrower. On a platform such as Mintos with limited information on the borrower, it might be more useful to look at the APR to make sure that the borrower is offered sustainable terms for repayment.
The ethical decisions will also vary based on the information provided. There is not much to make decisions on, on a platform like Mintos. However, on platforms such as Estateguru and Crowdestate, there is more information available to help with the transparency. The transparency of financials can help the investor evaluate the sustainable and ethical measures of financing for the borrower.
Know the borrower or area: Where it is possible knowing the borrower or area of the project is good for the ethical evaluation. If there is a real estate developer building a residential apartment complex in an emerging part of town, it helps to grow and expand the infrastructure.
The effective APR: Whether the borrower is private or corporate the effective APR is good to know to figure out how sustainable the economic growth is for the borrower. In case of a real estate developer, it is not possible to pay a 50% APR. Real estate is a so competitive business, hence big interest rates would kill their business. The same for private individuals. Most people live paycheck to paycheck, and thus big interest rates would prohibit sufficient repayments of their debt.
Can Investors Influence The Ethics Of The Loans?
Investors has a lot to say in the investments made on the P2P lending platforms. The 2 projects that was to fund fur companies both got terrible feedback. They were funded very slow compared to other projects. The CEO of Crowdestor is a part of the Facebook P2P Investment Fellows which is a big network of investors talking about P2P lending.
The CEO of the platform was present in the comments to give explanations on the project. The projects got funded they saw massive critique on Facebook and other social media for including the project in their portfolio. While the 2 fur loans got funded there has been no loans of this unethical status since then, which means that investor must influence the industry. It all comes down to supply and demand. If the loans provided is seen as unethical, there will be no supply to the loan, and therefore the demand/market will go away.